As far back as his time as an academic, Bernanke made clear that when the going got tough, he wouldn’t hesitate to fire up the printing presses. He specialized in studying the Great Depression and, contrary to greater minds like Murray Rothbard, determined that the problem was too little money printing. He went on to propose several ways the central bank could create inflation even when interest rates had been dropped to zero through large-scale asset purchases (LSAPs). Sure enough, the credit crunch of 2008 gave the Fed Chairman an opportunity to test his theory.

All told, the Fed spent $2.35 trillion on LSAPs, including $1.25 trillion in mortgage-backed securities, $900 billion in Treasury debt, and $200 billion of other debt from federal agencies. That means the Fed printed the equivalent of 15% of US GDP in a couple of years. That’s a lot of new dollars for the real economy to absorb, and a tremendous subsidy to the phony economy.

This has bought time for President Obama to enact an $800 billion stimulus program, an auto industry bailout, socialized medicine, and other economically damaging measures. In short, because of the Fed’s interventions, Obama got the time and money needed to push the US further down the road to a centrally planned economy. It is also now much more unlikely that Washington will be able to manage a controlled descent to lower standards of living. Instead, we’re going to head right off a fiscal cliff.

The Fed Chairman even admitted to this reality in his statement. Here are two choice quotes:

“As I noted, the Federal Reserve is limited by law mainly to the purchase of Treasury and agency securities. … Conceivably, if the Federal Reserve became too dominant a buyer in certain segments of these markets, trading among private agents could dry up, degrading liquidity and price discovery.” [emphasis added]

“…expansions of the balance sheet could reduce public confidence in the Fed’s ability to exit smoothly from its accommodative policies at the appropriate time. … such a reduction in confidence might increase the risk of a costly unanchoring of inflation expectations, leading in turn to financial and economic instability.” [emphasis added]

So we all agree that the prospect of inflationary depression was made worse by the Fed’s actions – but at least Ben Bernanke has pleased his boss. As a guaranteed monetary dove, Ben Bernanke appears to be a shoo-in if Obama is re-elected.

Meanwhile, Mitt Romney has pledged to fire Bernanke if elected. While I am not confident that Mr. Romney has the economic understanding to appoint a competent replacement – let alone pursue a policy of restoring the gold standard or legalizing competing currencies – he may well be seen as a threat not only to the Fed Chairman’s self-interest, but also to his inflationary agenda.

Given this background, let’s look at Bernanke’s quotes that have been the focus of media speculation for the past week: the US economy is “far from satisfactory,” unemployment is a “grave concern,” and the Fed “will provide additional policy accommodation as needed.” These comments seem designed to reassure markets (and Washington) that there will be no major shift toward austerity in the near future. The party can go on. But they also hint that Bernanke might be planning to double down again. I have long written that another round of quantitative easing is all but inevitable. It now seems to be imminent.

In reality, when the money drops may have more to do with politics than economics. The Fed may not want to appear to be directly interfering in the election by stimulating the economy this fall, but there are strong incentives for Bernanke to try to perk up the phony recovery before November and deliver the election to Obama. However, if Romney wins, Bernanke can at least fall back on his appeal as a team player as he lobbies for another term.

For gold and silver buyers, either scenario is likely to continue to stoke our market in the short- and medium-term. As the past week’s rally indicates, there is no longer a fear that the Fed has had enough of money-printing – in fact, it looks prepared for much more.

“Not only is Europe slipping more rapidly into a deeper recession but the implementation of serious and effective longer-term policy responses remains unlikely. Band-Aid policy measures of providing liquidity (which aids the transmission of monetary policy) remain the operative palliative, and they will likely continue for some time to come.”

And he argues that the U.S. serves as a pretty good model for what’s to come:

“…we can look at the massive doses of monetary stimulation in the U.S. as a template. Despite unprecedented easing, we are now more than three years after the Great Recession of 2008-2009, and the domestic economic economy is growing (in real terms) at only 1.8%. Given the more dire state of the eurozone (accelerating inflation, decelerating economic growth and rising unemployment), how will it be possible for Europe to grow out of its debt problem? The answer is that it won’t be able to without the heavy lifting and unpopular policies that could encourage growth by cutting expenditures and balancing trade.”

If this really goes operational (which will require the full activation of the bailout schemes, and the willingness of countries like Spain to submit to outside review) the ECB then has the firepower to take tail risk off the table.

In fact, Draghi specifically said that was the goal: Taking tail risk off the table.

The big question is: how will this different than past bond buying programs? One reporter during the Q&A noted that the ECB has done this twice before.

Draghi’s basic answer: Countries will be subject to conditionality (making bond purchases part of fiscal consolidation) and it will be unlimited. Also it will be transparent.

The mos tension during the Q&A came when German reporters pestered Draghi about the legitimacy of the program, and whether this is really legal under the ECB’s mandate.

Draghi insists it is. He says that it’s consistent with the mandate for price stability and that even in the origanl ECB charter, bond purchases have been anticipated.
ECB press conference was the first time that the bank was expected to announce a real game changer for the euro crisis.

The reason? For the first time, it looks like the ECB is seriously going to open up its unlimited pocketbook and buy bonds agressively to depress yields.

Usually the ECB disappoints when it has a press conference, but this time the markets seem to like what happened. European bond yields are falling, and the Dow is up 130.

The hallmark news of the day was the existence of a new plan: The OMT, which stands for OutrightMonetary Transactions.

Previously, when the ECB did bond buying it was under a program called the SMP: Securities Market Program.

The new plan rests on 5 pillars:

Conditionality. Strict and effective conditionality is attached to ECB purchases of sovereign debt. What this means is: No country gets to have their bonds purchased unless they submit to outside oversight on fiscal matters. IMF observation will get re-elected. Draghi threatens to terminate actions in non-compliance.

Unlimited purchases of 1 to 3 years.

ECB is no longer senior. ECB expects the same Pari Pasu treatment.

Sterilization: The liquidity created through outright transactions will be sterilized.

Transparency: Purchases to be revealed on a weekly and monthl

basis.

Basically, so long as governments submit to outside observation of fiscal consolidation plans, the ECB will buy 1-3 year debt in unlimited levels.

If this really goes operational (which will require the full activation of the bailout schemes, and the willingness of countries like Spain to submit to outside review) the ECB then has the firepower to take tail risk off the table.

In fact, Draghi specifically said that was the goal: Taking tail risk off the table.

The big question is: how will this different than past bond buying programs? One reporter during the Q&A noted that the ECB has done this twice before.

Draghi’s basic answer: Countries will be subject to conditionality (making bond purchases part of fiscal consolidation) and it will be unlimited. Also it will be transparent.

The mos tension during the Q&A came when German reporters pestered Draghi about the legitimacy of the program, and whether this is really legal under the ECB’s mandate.

Draghi insists it is. He says that it’s consistent with the mandate for price stability and that even in the origanl ECB charter, bond purchases have been anticipated.

The market seems to like it: The Dow is surging 150 points, hitting the highest level in 52 weeks.

High unemployment and inflation below the Fed’s 2 percent target “would argue for additional accommodation now,” Williams said today in an interview on Bloomberg Television from Jackson Hole, Wyoming. “I would like to see something that has a measurable effect on job growth. That would be arguing for a pretty large program” that’s “at least as large as QE2,” or the second round of quantitative easing, he said.

Federal Reserve Bank of San Francisco President John Williams called for additional bond purchases by the Fed to spur economic growth that would be open- ended and total at least $600 billion.

High unemployment and inflation below the Fed’s 2 percent target “would argue for additional accommodation now,” Williams said today in an interview on Bloomberg Television from Jackson Hole, Wyoming. “I would like to see something that has a measurable effect on job growth. That would be arguing for a pretty large program” that’s “at least as large as QE2,” or the second round of quantitative easing, he said.

Jonh Mauldin comments:

“No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future.”

– Ludwig von Mises

We heard from Bernanke today with his Jackson Hole speech. Not quite the fireworks of his speech ten years ago, but it does offer us a chance to contrast his thinking with that of another Federal Reserve official who just published a paper on the Dallas Federal Reserve website. Bernanke laid out the rationalization for his policy of ever more quantitative easing. But how effective is it? And are there unintended consequences we should be aware of? Why is it that the markets seem to positively salivate over the prospect of additional QE?

I missed the part where Congress gave the Fed a third mandate, to target the stock market. But Bernanke not only takes credit for the stock market, he points out that the rebound in the housing market is also due to Fed policy, because it fostered lower mortgage rates. Which it did. But let’s also remember that it was Fed policy that helped create the housing bubble to begin with. Which I don’t remember Bernanke taking credit for, even though he was on the Fed then and up to his eyeballs in supporting that policy.

Joan McCullough, in her own irreverent style, gave us a few must-read paragraphs this afternoon:

“And then [Bernanke] has the sand to make a public comment that stocks go up when he prints money because discount rates have gone down and the economic outlook has improved on account of it? This is what makes the hot dogs run stocks up the flagpole when The Bernank saddles up? Better economic outlook? Amazing.

Paul Ryan is worried about the Federal Reserve. He is worried the Federal Reserve will try to bring unemployment down. There’s a word for this. I can’t print it, because this is a family publication.

For the past four years, Ryan has repeatedly warned about the real menace threatening the economy: inflation. Forget that long-term unemployment has surged to levels not seen since the Great Depression, and prices have barely risen — Ryan is scared of the inflation monster under his bed, and thinks you should be too. He thinks that trying to bring down unemployment will unleash the inflation monster — and that’s why he wrote an op-ed in the Wall Street Journalback in May of 2008 calling on Congress to revoke the Fed’s dual mandate to target both low inflation and low unemployment. He wants the Fed to only worry about the former and not the latter.

Ryan is pushing bad economics, and worse history. The chart below looks at core PCE inflation — the Fed’s preferred measure — since Congress passed the Humphrey-Hawkins Act in 1978 that gave the Fed its dual mandate. After spiking due to the second oil shock, inflation has been on a steady downward trajectory for the past 30 years.

It takes a vivid imagination to interpret this as evidence that Humphrey-Hawkins has caused an inflation problem. Reality says the opposite. Actually, it’s much, much worse for Ryan — the Fed has gotten much, much better at maintaining price stability since the advent of the dual mandate. We don’t have data on core PCE inflation before 1959, but we do have numbers for CPI inflation — that is, including food and energy costs — going back to 1914. Which period looks like the nirvana of price stability to you in the chart below? (Note: the yellow dot shows when Humphrey-Hawkins became law).

There was 4.4 times more variance in prices before the dual mandate than after it. And those first 20 years came under the gold standard — which its advocates today claim would “cure” inflation! This last point is crucial because Ryan has something of a soft spot for goldbugs. Now, Ryan doesn’t want to bring back the gold standard itself, but he does want to create a commodity standard — in other words, tie the value of the dollar to a basket of commodities. This is a distinction without much of a difference. The Fed would have to raise interest rates when commodity prices go up, regardless of the state of the economy. This is all kinds of crazy. Commodity prices have shot up the past decade as developing nations have developed — unrelated to inflation here. It makes no sense to make our economy worse because China’s economy is getting better.

Where did Paul Ryan get such a truly nutty idea? It’s not from the hero of conservative economic thought, Milton Friedman. Republicans have abandoned Friedman — at least when it comes to monetary policy. (Although libertarians and conservatives like Scott Sumner, David Beckworth, and Evan Soltas still carry the Friedman torch). Friedman’s insight was that low interest rates don’t necessarily mean that Fed policy is easy — usually the reverse — and that the Great Depression wouldn’t have been quite so great if the Fed had printed money to prevent the banking collapse. Ryan hasn’t just ignored Friedman; Ryan is the anti-Friedman. He has sharply criticizedFed ChairmanBen Bernanke for printing money, and issued melodramatic (and incorrect) predictions about “currency debasement.”

Why is Ryan so out of step with what conservatives used to believe about monetary policy? Because he takes his cues on the Fed from a fiction writer instead of a Nobel laureate.

English: Representatives to the Conference on Unemployment The meeting was called by U.S. President Warren G. Harding in response to the 1921 recession. (Photo credit: Wikipedia)

More than two years before the housing bubble burst in 2006, economist Gary Shilling warned that subprime loans were probably “the greatest financial problem” for the future U.S. economy. In 2007 he said “housing would sink the economy,” and a year after that he warned of a “serious recession” that would consume most of 2008. He was right every single time.

Now Shilling says a new recession has begun in the U.S. — in the second quarter — following on the heels of the recession in Europe. He says the current recession is different from previous ones because it wasn’t caused by rising rates or another housing downturn but rather a drop in consumer spending due to a weak job market.

“We’ve had three consecutive months of declines in retail sales,” says Shilling, president of A. Shilling & Co., an economic research and forecasting firm. “That’s happened 29 times since they started collecting the data in 1947, and in 27 of the 29 we were either in a recession or within three months of it.”

Shilling expects this recession will last about a year and shave about 3.5% from growth from peak to trough.

This time is different, says Shilling “because a lot of things that normally go down in a recession are already there, like housing.” And policies that normally help revive the economy are absent. The Fed can’t cut interest rates because they’re already near zero and the housing market won’t be a catalyst for growth, Shilling says.

One thing that hasn’t changed, says Shilling, is the economy as the number one issue in the presidential election. Before the last presidential election Shilling said that whoever got elected then wouldn’t get re-elected because the economy would still be weak with high unemployment.

Now Shilling says he’d like to see one party in control in Washington because it increases the odds of cuts for entitlements and could help “restore confidence in Washington.” But even then he says it will take five to seven years to complete the deleveraging that’s already underway before the economy recovers.

But Gary Shilling of A. Gary Shilling is not convinced home prices have turned to the upside for good.

“The fundamental reason is there is a huge excess of inventory out there,” he tells The Daily Ticker’s Henry Blodget. “Some of it is listed but a lot of it is a so-called shadow inventory.”

Shadow inventory refers to homes in foreclosure and waiting to be sold or properties that homeowners have delayed selling, likely to get a better price.

In his latest Insights investment note, Shilling writes “excess housing inventories, the mortal enemy of prices, measure about 2 million over and above normal working levels. That‘s huge considering that housing completions averaged about 1.5 million in earlier balmy years.”

He also cites the backlog of delinquencies and foreclosures that were put on hold during the robo-signing investigation and settlement process.

A CoreLogic report in June showed shadow inventory fell almost 15 percent from 2011 levels to 1.5 million properties. More than half of those 2.8 million homes were “seriously delinquent, in foreclosure or REO.”

“Since peaking at 2.1 million units in January 2010, the shadow inventory has fallen by 28 percent. The decline in the shadow inventory is a positive development because it removes some of the downward pressure on house prices,” said CoreLogic chief economist Mark Fleming. “This is one of the reasons why some markets that were formerly identified as deeply distressed, like Arizona, California and Nevada, are now experiencing price increases.”

As Shilling sees it, the banks have three options to get the bad mortgages off their books:

Flood them onto the market

Institute a mortgage modification plan

Try to convert the properties into rentals

He says the second and third options are a lot less likely because mortgage modifications rarely work and rental properties are very difficult to maintain on a large scale, which may detract institutional inventors.

As a result, he believes the more likely scenario could very well end up being option number one, which would have a negative impact on home prices. The latest National Association of Realtors survey showsforeclosed properties tend to sell at a 19 percent discount to the market.

Too many foreclosures flooding the market at the same time could drive down prices of the surrounding homes.

“It would take a 22% house price drop to return to the long-run trend going back to 1890,” he writes in his research note. “Since corrections of bubbles often overshoot on the downside, our forecast of a further 20% decline may be conservative.”

The past week provided clear lessons not just in how central bankers have a limited ability to positively influence the economy but also how they are limited in their capacity to deliver the shortsighted policy actions that investors currently crave. The developments should provide new reasons for investors and economy watchers to abandon their faith in central bankers as super heroes capable of saving the economy.

The employment report released on Friday confirmed that the U.S. economy is stagnating at best and actively deteriorating at worst. While the numbers of jobs created in July was actually better than many economists expected, it was still far below the levels that would indicate a growing economy. But more important than the official unemployment rate (which ticked up to 8.3%) or the number of jobs created, is the number of people who have left the workforce out of frustration or despair. This number continues to head higher. The labor force participation rate, which is the percentage of healthy working age Americans who actually have jobs, is at one of the lowest points since women first started working en masse in the 1970’s. It’s also instructive to add back into the unemployment rate those who want full time jobs but who have had to settle for part time work. This figure, reported under the “U6” category, currently stands at 15.0%. This is just a 12% decline from the 17.1% high seen December 2009. In contrast the “official” (U3) unemployment figure has declined 17% from its peak.

In explaining these bad results, most economists simply look at the stimulating effects of monetary and fiscal policy,not at the problems that those measures create. As a result, it is assumed that not enough stimulation, in the form of quantitative easing or federal deficit spending has been applied to the economy. The next logical assumption is that if the measures of the past few years had not been applied, we would have seen much weaker results over that time. In other words, no matter how bad things are now, defenders of the status quo will always describe how bad things “could have been” if the Fed hadn’t stepped in. This counterfactual argument gets increasingly threadbare as the years wear on.

Rather than admit that its policies have failed, the Fed statement last week gave all indications that it will continue with its current inflationary policy to the bitter end. These are the same errors that inflated the stock and real estate bubbles and ultimately resulted in the 2008 financial crisis and our continuing economic malaise. Without any fresh ideas,Fed press releases have become a Groundhog Day repetition of the same pronouncements and diagnoses. Oddly, many market watchers are frustrated that the Fed has not telegraphed that more stimulus is forthcoming. While it should be obvious that our current “recovery” is dependent on monetary support, it should be equally plain that the Fed can’t actually admit that fragility without spooking markets. To be clear, QE III is coming, but the markets should not expect Bernanke to supply a precise timetable.

Without question, if the Fed had not stimulated the economy with zero percent interest rates, two rounds of quantitative easing and operation twist, the initial economic contraction would have been sharper. But such short-term pain would have been constructive. By not taking away the cheap-money punch bowl, the Fed has delayed the pain and prolonged the party. But to what end? So far all we have received is a tepid phony recovery that has sown the seeds of its own destruction.

In contrast, real economic restructuring would have resulted if the Fed had withdrawn its monetary props. This would have paved the way for a robust, sustainable recovery. Instead, the Fed helped numb the pain with unprecedented (and apparently permanent) liquidity injections. Its actions merely exacerbate the underlying imbalances that lie at the root of our structural problems, and thus act as a barrier to a real recovery. So long as the Fed fails to learn from its prior mistakes, the phony recovery it has concocted will continue to fade until we find ourselves in an even deeper recession thanthe one we experienced in 2008.

Those who believe that artificially low interest rates are needed now,fail to see the price that will be paid down the road. By keeping rates too low, the Fed continues to lead an overly indebted economy deeper into the financial abyss. However, its ability to maintain rates at such low levels is not without limits. Just as real estate prices could not stay high forever, interest rates cannot stay low forever. When rates finally rise, the extent of the economic damage will finally be revealed.

The sad fact is that no matter how impotent and dishonest Fed officials become, their elected rivals on Capitol Hill (who control the fiscal side of the equation) have become even less significant. The complete lack of any political conviction to take steps to confront our fiscal imbalances means that Ben Bernanke and his cohorts are seen as the only cavalry capable of riding to the rescue. But no matter how often they blow their bugles,our economy will continue to deteriorate until we stop waiting for a savior and instead fight the battle for prosperity ourselves.

Gross, the co-founder and co-chief investment officer of bond giant PIMCO, says it is time to write the obituary for stock investing as we know it.

Writing in his August investment letter, the manager of the world’s largest bond mutual fund said lower returns on stocks — and bonds, for that matter — means individuals will have to work longer to save for their retirements.

If financial assets no longer work for you at a rate far and above the rate of true wealth creation, then you must work longer for your money

“If financial assets no longer work for you at a rate far and above the rate of true wealth creation, then you must work longer for your money,” Gross wrote.

Gross, whose Pacific Investment Management Co has US$1.82-trillion in assets, took particular issue with the noted economist Jeremy Siegel, who popularized the notion that a portfolio of stocks can return on average 6.6% over the long haul.

“The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned,” he said.

In his April investment letter, Gross struck a similar tone on total return expectations. Gross then said investors should get used to smaller investment returns because of slower global growth and as the financial services industry continues to deleverage, or reduce its reliance on derivatives and borrowed money to generate higher returns.

This time around, Gross said at their currently low interest rates, investors should expect “mere survival” from their bond investments.“With long Treasuries currently yielding 2.55%, it is even more of a stretch to assume that long-term bonds – and the bond market – will replicate the performance of decades past,” he wrote.

In his August letter, Gross says the only “magic potion” monetary policymakers have to try and get higher returns for investors is through inflationary policies.

He said inflationary policies might work for bonds, but that they are bad for stocks. And over the long term, Gross said using inflation to solve retirement ills is not a real solution.

“Unfair though it may be, an investor should continue to expect an attempted inflationary solution in all almost all developed economies over the next few years and even decades,” Gross wrote. “The cult of equity may be dying, but the cult of inflation may have only just begun.”

“The problem with all of that of course is that inflation doesn’t create real wealth and it doesn’t fairly distribute its pain and benefits,” he continued.

Gross in June kept the proportion of U.S. government and Treasury debt in his US$263.4-billion Total Return Fund unchanged at 35% of assets, according to a report July 11 on the company’s website. Mortgages were at 52% for a second consecutive month. Pimco doesn’t comment directly on monthly changes in its portfolio holdings.

In developed nations, Gross has advised investors to favor debt of the U.K., as well as the U.S., as Germany faces risks related to the eventual costs required to end the region’s worsening sovereign and banking crisis.

The U.S. Treasury market is considered the cleanest “dirty shirts” for investors, Gross wrote in his previous commentary. “Don’t underweight Uncle Sam in a debt crisis. Money seeking a safe haven will find it in America’s deep and liquid, almost Aaa rated, bond and equity markets.”

Pimco’s Total Return Fund gained 7.3% during the past year, beating 73% of its peers, according to data compiled by Bloomberg.